1. Is debt not also subject to commercial and defense risk, and should we therefore not try...
Question:
1. Is debt not also subject to commercial and defense risk, and should we therefore not try to back out the commercial risk component?
2. Why not simply use the CAPM to estimate the cost of debt?
3. Should you calculate a weighted average of all debt or a weighted average of long-term debt with maturities that match the length of the project?
The motives for the project are laudable: the 7E7 is entering a good growth segment of the industry. Higher performance and fuel efficiency will position Boeing favorably in the market, and perhaps, take back some market share from competitors. R&D on this project may create inventions that will prove to be valuable to other Boeing products. At the same time, the consequences of error are staggering: this is a bet-the-ranch kind of investment.
But, as most entertainers know, timing is everything. Here, the timing could not be worse: war, airline-focused terrorism, SARS, and the weak financial condition of airlines all challenge the approval of the project. “Why now?” is a question that the board must answer. In part, the answer depends on the long development cycle (four years) and very long product lifecycle (20 years). The board is making a bet less on conditions that prevail today than on conditions that are expected to prevail many years into the future.
Step by Step Answer:
Case Studies in Finance Managing for Corporate Value Creation
ISBN: 978-0077861711
7th edition
Authors: Robert F. Bruner, Kenneth Eades, Michael Schill